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Performance and Policy

Real GDP Corrects for price changes

Nominal GDP Uses current prices Unemployment Inflation

Increase in overall level of prices

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Performance and Policy

Can governments: Promote economic growth?

Reduce severity of recession? Is monetary or fiscal policy more

effective at mitigating recession?

Is there a tradeoff between inflationand unemployment?

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Economic Performance

Output growth 3.1% per year 1995-2005

Unemployment rate 4.6% in 2007

Inflation rate 2.7% in 2007

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Economic Growth

Standard of living measured byoutput per person

No growth in living standardsprior to Industrial Revolution Modern economic growth

Output per person rises Not experienced by all countries

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GDP Per Person 2007

Zimbabwe $188

United States $45,845

Canada $38,345

Japan $33,576

United Kingdom $35,134

South Korea $24,782France $33,187

Russia $14,692

Saudi Arabia $23,243

Burundi $371Tanzania $1,256North Korea $1,900India $2,659China $5,292

Mexico $12,774

U.S. dollars based on purchasing power parity

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Savings and Investment

Saving Tradeoff current for future

consumption

Investment Financial investment

Economic investment Banks and financial institutions

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Expectations

The future is uncertain Expectations affect investment

Shocks What happens is not what you

expected

Demand shocks Supply shocks

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Shocks

Demand shocks and flexible prices Price falls if demand low Sales unchanged

Demand shocks and sticky prices Maintain inventory

Sales change Business cycles

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Demand Shocks

Cars per week

P r i c e

DM

DL

DH

900

$40,000

$37,000

$35,000

Flexible Prices

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Demand Shocks

Cars per week

DM D

L

DH

700 900 1150

$37,000

Fixed Prices

P r i c e

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Sticky Prices

Explain fluctuations is GDP Average months between price changes

Coin-operated Beer 4.3Laundry Machine 46.4 Microwave Ovens 3.0Newspaper 29.9 Milk 2.4Haircut 25.5 Electricity 1.8

Taxi fare 19.7 Airline ticket 1.0Veterinary service 14.9 Gasoline 0.6Magazine 11.2 Computer software 5.5

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Sticky Prices

Many prices sticky in short run Consumers prefer stable prices

Firms want to avoid price wars All prices flexible in long run

Firms adjust to unexpected, butpermanent changes in demand

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Inventory Management

Computerized inventory tracking Unexpected changes in demand

easier to observe Firms make better output and

employment decisions

Less severe business cycles Only two mild recessions sinceadoption

Possible explanation 6-13

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Key Terms

business cycle recession real GDP

nominal GDP unemployment inflation

modern economicgrowth savings

investment

financial investment economic investment expectations

shocks demand shocks supply shocks

inventory inflexible prices(sticky prices)

flexible prices 6-14

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Measuring

Domestic Outputand National

Income

6-15